An acquisition and a lofty P/E isn't enough to shake this Fool out of his shares.
One of my oldest holdings, Halma (LSE: HLMA), announced an acquisition yesterday. The scale wasn't much by the standards of the market -- £15.7 million -- and it's chicken feed in comparison to Halma's £1.2 billion market capitalization.
Yet I smiled as I read the RNS, in the way that a parent smiles when handing over money for a child's music lessons.
You see, this acquisition sums up everything that's right about this quality manufacturer. And I'm pretty confident that in time Halma -- which in summer extended its unbroken run of 5% or higher dividend increases to a glorious 31st year -- will get a lot more out of Alicat Scientific than it's paid for it.
Tick tock growth
I wrote about Halma in some detail in June 2009, explaining how it consisted of a conglomerate of companies grouped under three divisions -- Infrastructure Sensors, Health and Analysis, and Industrial Safety – and concluding that it was a "must" for income portfolios.
The shares have done well since then, and I'm half-pleased with my assessment. But only half-pleased -- to be more specific, the shares have nearly doubled from 172p to 330p, and I wish I'd concluded they were a must for ALL portfolios!
The trouble is Halma shares rarely look a bargain -- as some of my favourite Fools were discussing just recently -- and that's still the case today.
Yet if anything I've grown even more impressed with the firm, given how it has accelerated out of the downturn.
Both profits and earnings per share kept rising despite the worldwide recession, and as mentioned the dividend was increased, too. The company also reversed a net debt position of £51 million when it started its 2010 financial year to £9 million net cash by the April finishing line.
| ||Revenue||Pre-tax profit||Earnings per share||EPS growth||Dividend per share|
Source: Digital Look; 2011 represents a consensus of analysts forecasts
Now, earnings per share of 10-15% per year -- even through a deep recession -- is not going to get a hedge fund manager's pulse racing, but if every share in my portfolio could achieve it consistently I'd be a very happy man. Such growth is sufficient to more than double earnings every seven years or so, and for a committed dividend payer like Halma that means a roughly doubling in income, too.
Grow, grow, grow your moat
Returning to the takeover news, Halma has paid £15.7 million for Alicat Scientific, with an option to increase or reduce this figure depending on how the books look when Halma has finished integrating it. It bought the company with a mixture of debt and cash.
Alicat made £2 million profit last year, and Halma says the purchase should be immediately earnings enhancing. There's also a strategic benefit, says CEO Andrew Williams:
"Alicat adds new technologies and end market applications to our Fluid Technology businesses which currently focus on fluid flow via precision miniature tubing assemblies, connectors and valves. This acquisition provides new cross- selling opportunities and the Halma hubs in Asia will help Alicat accelerate their recent sales growth in that important region."
Small acquisition price, yet another niche player, an immediate boost to profits (cheap 'just-in-time capex' is how I heard one fund manager describe strategic acquisitions in the current climate) and the chance of "accelerating growth" -- what's not to like?
Furthermore, the great thing about Halma's distributed structure is that a modest acquisition like Alicat can just slot in without major restructuring, given the decentralized way the company is run, yet can still benefit from some economies of scale and expertise from across the group.
Obviously this doesn't remove the risk of making a duff purchase altogether, but it does reduce the problem of an immediate culture clash.
You pay for quality
I think Halma is one of the London market's most attractive companies.
It seems to have mastered the trick of running lots of small, entrepreneurial outfits under the wing of a larger, stable entity -- often tried, but rarely with such success. It operates in niches such as health and safety and precision engineering, where cost cutting does not come first. And it's well placed for developing world growth -- sales to China increased 59% last year.
But what does it currently cost to buy into this attractive income play?
At 330p, the shares are on a high P/E of 20, falling to 17 in 2011. The prospective dividend yield is just 2.8%, though more than twice covered. The PEG rating is a little over one -- not a disaster, but no obvious bargain. I would expect net debt to be neither here nor there, irrespective of yesterday's acquisition.
As usual then, Halma shares do not look cheap. But what price do you put on a company that has grown dividends for 31 years and made a profit in the worst global downturn since at least the Second World War?
At the risk of being too cautious once more, I'd suggest new buyers wait for a dip to say 300p before buying in, for a forward P/E of around 15, just to introduce some margin of safety. The share price was under 280p as recently as September, so that's not a forlorn hope.
Of course, we may not see the other side of 300p again. Companies like Halma seem sent to test us. Stock market history is littered with steady performers that eventually blow up -- Rentokil (LSE: RTO) anyone? But while the story holds, there are few more enjoyable investments to own.
More from Owain Bennallack:
> Owain owns shares in Halma.